#economics #savemyexams #pricechanges

• In September 2022, Hurricane Fiona destroyed much of Puerto Rico's crop of plantains (a necessity in the diet of local people).

Diagram showing a decrease in supply of plantains in Puerto Rico due to a supply shock caused by Hurricane Fiona

Diagram analysis

• Due to Hurricane Fiona, Puerto Rico is experiencing a supply shock in its plantain market.

  
  

  *This causes a decrease in supply of S1→S2.

  
  

• At the original market clearing price of P1, a condition of excess demand now exists (shortage)

  
  

  *The demand for plantain is greater than the supply.

  
  

• In response, sellers in Puerto Rico raise prices.

  
  

  *This causes a contraction of demand and an extension of supply leading to a new market equilibrium at P2Q2.

  
  

  * The equilibrium price (P2) is higher and the equilibrium quantity (Q2) is lower than before.

  
  

  *The excess demand in the market has been cleared.

Real world example: changes to demand that decrease price

• Demand for lobsters in Maine, USA has been falling steadily in recent months.

• This has resulted in a price fall from $12.35 per pound on April 1st to $9.35 per pound on May 1st.

Diagram showing a decrease in demand for lobsters due to a decrease in real income

Diagram analysis

• In recent months, the USA has been experiencing an increasing rate of inflation.

  
  

  * Inflation lowers the purchasing power of money in a consumer's pocket and, therefore, effectively reduces their real income.

  
  

  * With reduced real income, fewer luxuries are consumed.

  
  

  * This led to a decrease in demand for lobsters from D1→D2.

At the original market clearing price of P1, a condition of excess supply now exists.

* The demand for lobsters is less than the supply.

• In response, suppliers gradually reduce prices

  * This causes a contraction of supply and an extension of demand, leading to a new market equilibrium at P2Q2.

  * Both the equilibrium price (P2) and the equilibrium quantity (Q2) are lower than before.

  * The excess supply in the market has been cleared.

Real world example: changes to supply that decrease price

• In order to help meet their climate targets and lower energy costs for households, the EU is providing subsidies for solar panels.

Diagram showing an increase in supply of solar panels in the EU due to a per unit subsidy

Diagram analysis

• To help meet its climate change targets and lower household energy bills, the EU has provided a subsidy to solar panel retailers.

  *This causes an increase in supply of S1→S2.

• At the original market clearing price of P1, a condition of excess supply now exists (surplus).

  * The supply of solar panels is greater than the demand.

• In response, sellers in the EU lower prices.

  * This causes an extension of demand and a contraction of supply, leading to a new market equilibrium at P2Q2.

  
  

  * The equilibrium price (P2) is lower and the equilibrium quantity (Q2) is higher than before.

  
  

  * The excess supply in the market has been cleared.